Indonesia struggles to solve politically toxic fuel subsidy problem

Scraping out a living on $5 a day, taxi driver Sukarjo fears losing what many poor Indonesians see as the main economic help they get from their government: a subsidy that allows for Asia's cheapest fuel prices.

Indonesia's government is again trying to confront runaway fuel subsidy costs that now account for more than 30 percent of state spending and are draining funds that should be going for much-needed infrastructure in Southeast Asia's largest economy.

President Susilo Bambang Yudhoyono's administration could announce this week new measures to restrict use of subsidized fuel. But with elections looming next year, and memories fresh of violent protests over fuel-price rises in 2005 and 2008, he is expected to bow to the populist wishes of voters such as Sukarjo and not scrap subsidies.

"Our current burden is already heavy," the 45-year-old father of two said while waiting for customers in his white Toyota taxi. "I cannot imagine how difficult my life will be if a policy (to raise prices) is passed."

One option the government has is to ban private cars from using subsidized fuel in Jakarta and other large cities. But critics say that will be hard to enforce and would do little to ease the huge burden on the national budget. Last year, the bill for subsidies was $22 billion - nearly 4 percent of total economic output.

"Any scheme that doesn't eliminate fuel subsidies altogether won't work," Suryo Bambang Sulisto, chairman of Indonesia's influential chamber of commerce (Kadin), told Reuters.

"Subsidies need to be abolished. They create a false economy that has led to a lot of corruption, a lot of smuggling and the misallocation of funds," he said.

INFLATION A CONCERN

Indonesia has long been under pressure to reduce the subsidies. But raising fuel prices is considered politically toxic ahead of elections next year. It could hurt low-income Indonesians and cause a spike in inflation, which has been in check.

Officials have already suggested there is little chance of any price rise this year, which raises the possibility that Yudhoyono will end up passing the problem to his successor when his second, and final, five-year term ends in October 2014.

For the moment, the government is hoping it can reduce what it spends on subsidies by curbing fuel consumption. Barring that, it may be forced to issue more bonds to cover an expanding budget deficit.

"There is not going to be any fuel price increase before the parliamentary and presidential elections in 2014," predicted Anthony Nafte, senior economist at CLSA Asia-Pacific Markets, noting that Indonesia's "energy subsidies are growing faster than all other fiscal expenditures".

"What they probably are going to announce are measures to restrict the use of subsidized fuel to try and reduce the volume of subsidized fuel. That scheme is not going to work," Nafte said.

SUBSIDY FOR THE RICH

A year ago this week, tens of thousands of Indonesians took to the streets against a government proposal to hike fuel prices by 33 percent. The effort failed and domestic fuel prices remain at around half the market rate.

A liter of unleaded gasoline sells for around 56 cents in Indonesia, against 61 cents in Malaysia and $1.71 in Singapore.

"Lifting the price is an option and (the president) has not closed that option. But as much as possible, he doesn't want to cause instability," said Tjokorda Nirata Samadhi, a deputy in the president's reform and delivery unit.

Nearly 15 years ago, protests over fuel price increases contributed to the downfall of autocratic President Suharto, an event still fresh in the minds of politicians eyeing 2014 presidential elections.

Economists say the fuel subsidies unfairly benefit wealthy and upper middle-class Indonesians who can afford cars. The World Bank estimates the average car owner saves around $100 a month from the cheaper fuel, while a motorcyclist's benefit is $10 a month and those riding on public transport only $1.

SUSTAINABLE SOLUTION NEEDED

"I can see the attractiveness of focusing on trying to cut the quantity of fuel use, but I think the only sustainable solution will have to involve a rise in prices," said Jim Bromby, lead economist for the World Bank in Indonesia.

Pushing up the government's giant subsidy bill has been annual economic growth of more than 6 percent. That's meant higher fuel consumption and, in turn, larger fuel imports. Indonesia is a net importer of oil, unlike years ago.

In 2012, fuel imports helped spawn Indonesia's first annual trade deficit and its first current account deficit since the 1997-98 Asian financial crisis. The deficits, in turn, hurt the rupiah, which last year was emerging Asia's weakest currency, shedding nearly 6 percent against the dollar.

If the government doesn't raise fuel prices, the IMF expects subsidy costs to stay at around 4 percent of GDP, contributing to a deepening of the current account deficit to around $29 billion from last year's $24.2 billion.

"If they don't get a credible subsidized fuel policy, you are just going to see more pressure on monetary and exchange rate policies to bear the burden," said Ben Bingham, the International Monetary Fund's Indonesia representative.

(Additional reporting by Adriana Nina Kusuma and Andjarsari Paramaditha,; Editing by Jonathan Thatcher, Jason Szep and Richard Borsuk)